Managers rotate back to UK domestics ahead of General Election 'clarity'

Managers rotate back to UK domestics ahead of General Election 'clarity'

Fund managers have been increasing their exposure to domestic UK stocks ahead of the 12 December General Election in the expectation that a Conservative Party majority will deliver a resolution to Brexit and avert the economic fallout of a Labour victory, thereby creating a bullish environment for domestically exposed stocks.

The most recent data (13 November) from polling company ComRes has the Tories on track to receive 40% of the vote, leaving Labour on 30%, though that would not deliver enough seats in the House of Commons to command a majority.

Domestic UK companies saw a brief boost last week after Nigel Farage confirmed his Brexit Party would not contest constituencies currently held by the Conservatives but would instead aim to make gains in Labour-held seats.

Sterling rose by 0.63% against the US dollar over the course of Monday (11 November) on the news, with Nigel Green, founder and CEO of deVere Group predicting the pound would get to $1.35 should the Tories win a majority. At time of writing, sterling was trading at $1.28. 

The pound is down 6.6% from the day after the EU membership referendum on 23 June 2016 to 14 November this year, having experienced a great deal of volatility over that time, particularly in the wake of pivotal moments in the Brexit debate. It has experienced lows of around $1.20 and highs of $1.40 during that period.

A Halloween horror, or a Ghost of Christmas Yet to Come?

A further lift in sterling would be positive for UK equities, particularly those with earnings derived in their home currency, according to Jonas Goltermann, senior markets economist at Capital Economics, who said that if the Tories win an outright majority "there is potentially significant upside for UK equities".

This is because "it could finally lead to a resolution to Brexit, which has held back the UK economy" and it would "probably lead to a significant fiscal stimulus", Goltermann explained.

A number of managers are encouraged by polling data and are positioning themselves for domestically focused firms to begin to show strong gains, including City of London investment trust, which predominantly invests in overseas-earning companies. 

Manager Job Curtis has recently been adding to domestic earners, with new holdings in Royal Bank of Scotland and supermarket Morrisons, as well as topping up his position in Lloyds Bank.

Curtis said: "[Last Monday], we had the news Farage was standing down against the Conservatives and top of the FTSE leaderboard were housebuilders, RBS and Lloyds. You saw the same when Boris Johnson did the deal with the Irish Prime Minister - you can see the pattern.

"I think the UK domestic stocks are so unloved and so out of favour - they are pricing in a pretty apocalyptic scenario. There would be a huge bounce if the Conservatives win a majority and bring forward the Brexit vote."

Ruffer Investment Company was another trust to have recently increased its weighting to domestic UK equities.

Lead manager Hamish Baillie explained: "Absent political noise, sterling would likely continue to strengthen, global bond yields may continue to rise, and UK equities will no longer carry a leper's bell."

Atlantic House Fund Management started buying UK domestic stocks late this summer, said head of multi-asset Charlie Morris. 

He explained: "They offer good value and attractive dividend yields. UK equities have been performing ever since the Prime Minister seemed likely to get a deal, and then again once he got a deal with the EU."

Tineke Frikkee, head of UK equity research at Waverton Investment Management, agreed a Conservative win would "reduce market uncertainty and thus the political risk discount on UK equities". Sterling would likely strengthen, she affirmed, "which should benefit UK domestic stocks more than overseas earners."

Beware 'market timing'

Douglas Scott, co-manager of the Kames UK Equity Income fund, also said his fund had been adding "selectively" to UK domestic equities, avoiding "areas where we see structural challenges" and focusing on "undervalued companies that should benefit from an element of political clarity".

However, he warned that in the unlikely event of a very large majority for Boris Johnson's party, this "may not be taken too well as it might empower the ERG to push for a harder Brexit".

Similarly Brooks Macdonald CIO Edward Park, who has also been adding to UK equities, cautioned investors against reading too much into election polling as the result will ultimately "be determined by the extent to which voters are willing to move across traditional political lines to support their Brexit view".

Manager of the AXA Framlington UK Select Opportunities fund Chris St. John warned against "market timing" with regard to UK equities, adding that the AXA IM UK equities team "do not think we can time the market, which is why we are not positioning for any particular outcome of the General Election". 

However, Simon Young, manager of the AXA Framlington UK Equity Income fund, acknowledged there will be a market reaction to the election, "especially if you get an extreme result either to the left or to the right".

He added: "The worst environment for businesses making investment decisions is uncertainty, so a hung parliament would also not be useful to anyone."

Dan Harlow, manager of the AXA Framlington UK Smaller Companies fund, said sentiment has been "profoundly negative towards UK domestics" since the referendum as a result of a "very close correlation between small- and mid-cap performance and sterling".

Therefore, he said, a clear parliamentary majority offering a boost to sterling would "be perceived to be positive for the domestic stocks".

From a market capitalisation perspective, funds targeting the smaller end of the UK corporate universe appear to have offered the best chance of outperformance. 

Of the 13 explicitly large-cap funds in the IA All Companies Sector with the required track record, seven have outperformed the sector average of 35.4% return since the day after the 2016 referendum, according to FE Fundinfo.

Of that seven, just one - Janus Henderson Inst Mainstream UK Equity - is a non-index fund, with iShares 100 UK Equity Index (UK) the best-performing having returned 39.1%. 

The same number of the 13 explicitly mid-cap funds with the required track records have outperformed the benchmark, with Franklin UK Mid Cap, ASI UK Mid Cap Equity and Royal London UK Mid-Cap Growth the standout performers over the period having delivered 58.8%, 58.5% and 50.1% each respectively.

Two of the seven are index funds, with iShares Mid Cap UK Equity Index (UK) and HSBC FTSE 250 Index returning 39% and 38.5% respectively. 

However, active mid cap also demonstrated underperformance, with Liontrust UK Mid Cap having delivered just 11.2% returns since the referendum. 

All three small/mid-cap funds have outperformed with BlackRock UK Special Situations delivering 57.6% over the period. 

From an overall perspective, 55.2% of funds with the required track records have outperformed, with MI Chelverton UK Equity Growth leading the pack with a return of 89%. 

The IA UK Smaller Companies sector has performed better than the IA All Companies overall with an average return of 48.2%; TM Cavendish AIM returned 113%. 

If the Conservatives do win a majority that allows Johnson's withdrawal agreement to be passed, "this would probably be positive for UK-focused companies, including those in the FTSE 250 or UK smaller companies, including AIM", said Rebecca O'Keeffe, head of investment at interactive investor.

O'Keeffe suggested the TB Amati UK Smaller Companies fund and Henderson Smaller Companies investment trust may benefit.

Research analyst at the Share Centre Helal Miah noted Johnson's deal "is a relatively hard Brexit", so suggested Schroder Income could "provide against uncertainties in future trade negotiations" due to its weighting to multinationals.


This article was first published on sister website